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Bottom-Fishing: The TROCL Risk System Explained

TROCL Risk System

The TROCL Risk scoring system quantifies the five factors that can turn a bottom-fish into a dud. The TROCL Risk ranking system can be applied to any speculative stock, though it is important to recognize that it does not evaluate a junior's merits or success potential. The lower the score, the better. As a stock's price increases the TROCL score can change, often to a worse score. Each risk factor is rated high (2), medium (1) or low (0). The TROCL Risk is the sum of the five factor ratings. A full score of 10 means you are dealing with a beast called a troglodyte which you want to avoid. TROCL risk scores above 5 generally disqualify a stock as a good bottom-fish.

TROCL Risk scores are re-assessed whenever the company is reviewed. The results show up in the Risk Analysis section of a company's profile in the following format:

TROCL Risk assessed as of February 25, 2003 - Overall Rating: 1+0+1+2+2=6
Timing Risk Reorganization Risk Opportunity Cost Risk Catastrophe Risk Liquidity Risk Overall Risk
Medium Low Medium High High Medium

Timing Risk:
When is something going to happen that will make this stock go up? Getting the timing right is the biggest headache in bottom-fishing. Everybody's goal is to buy a stock just before it goes up, but once it is apparent that the timing of a speculation cycle is imminent, very little stock remains available for accumulation at bottom-fish prices. So you have to bottom-fish when the timing is not obvious or clearly down the road. If the nature of a junior's story is such that key fundamentals needed to drive a speculation cycle will clearly take more than 12 months to materialize, or the company is contemplating a reorganization, the timing risk is high for a score of 2. On the minus side higher prices are a long time off, but on the plus side one has time to accumulate a good position at cheap prices. If a speculation cycle is imminent or underway the timing risk is low for a 0 score. The downside of a low timing risk is that the speculation cycle could collapse, a risk that would be reflected in a high catastrophe risk ranking. Another drawback of low timing risk is that the stock is no longer available at bottom-fish prices, at least not in meaningful amounts. A medium risk score of 1 is assigned when a speculation cycle could start within 12 months because either a work program is planned, or, in the case of a shell, the company is ripe for acquisition of a new story. A key aspect of the medium timing risk rating is that it remains uncertain that a speculation cycle, particularly a big one, will develop within 12 months. The probability of a decent speculation cycle will depend on the status of the overall market cycle.

Reorganization Risk:
A high reorganization risk or two score means that a junior plans to roll back its stock or merge with another company on rollback terms. A reorganization is bad for bottom-fishers because it not only implies lower prices, but also a minimum 3-6 month dead zone during which no speculation cycle will develop. Not until shareholder approvals have been obtained and the company refinanced through cheap paper will the stock be ready for a new story. Because of private placement hold restrictions, unless a junior is an Annual Information Form filer, which reduces the hold period from 12 months to 4 months, the wait for a bottom-fish with a high reorganization risk could be 12-18 months. A high reorganization risk is a signal for sophisticated bottom-fishers to check the situation out for "extreme" bottom-fishing opportunities. A medium risk score of one means that a rollback is not yet planned, but may soon be necessary if the next speculation cycle fails. Late life cycle juniors are usually assigned a high or medium reorganization risk. A low risk or zero score means there are neither reasons nor plans to do a rollback. A freshly reorganized junior or one that is well financed one with active projects will have a low reorganization risk.

Opportunity Cost Risk:
This is an attempt to quantify the upside potential of a junior's story. A high opportunity cost risk score of 2 is assigned when the story appears to have limited reward potential. An example would be a small vein target. If a story is mediocre it is not likely to generate a speculation cycle with an amplitude of 500% or better above the bottom-fish price range. During bull market cycles one wants to avoid high opportunity cost risk because investors will avoid stories lacking pie-in-the-sky potential. A zero score (low risk) generally applies when the market value of the junior is very low relative to the project outcome potential. In terms of the rational speculation model, high opportunity cost risk is equivalent to poor speculative value, and low opportunity cost risk is equivalent to good speculative value. A medium risk score is assigned when the story and its current pricing represents fair speculative value.

Catastrophe Risk:
If a junior's current value and future depend heavily on one individual or a specific project, the catastrophe risk is high with a 2 score. Speculators should be very careful when the catastrophe risk is high, particularly when the company's market capitalization is tied to a specific project. A high catastrophe risk rating is not a negative comment on the merits of the project, but just a warning that if something unexpected goes wrong, the stock will tank. Key man related high catastrophe risk is typically assigned to mid to late life cycle stocks where it is the reputation and drive of the key person that keeps the stock from undergoing a reorganization. Robert Friedland and the late Murray Pezim are examples of key people whose companies would be assigned a high catastrophe risk. A low catastrophe risk score of zero means that a junior has multiple projects and a management team in which leadership is not concentrated in one individual. A medium catastrophe risk rating is assigned to companies that fall between these extremes.

Liquidity Risk:
A high liquidity risk score of 2 means the stock is thinly traded at prevailing prices. If you do manage to accumulate a large position, be prepared to sit on it. On the plus side, when a speculation cycle kicks in for such a stock, the price can increase several times before selling develops, giving the bottom-fisher an instant windfall. Bottom-fish frequently have a high liquidity risk because the act of developing a bottom involves the disappearance of both sellers and buyers. A big spread between bid and ask is usually a good sign of poor liquidity. A high liquidity risk rating for a stock at the peak of a speculation cycle is a danger sign. A low liquidity risk with a zero score means that the stock trades actively at prevailing prices, allowing a speculator to move in and out at will without significantly disturbing the market. Generally only mid to late life cycle juniors get a low liquidity risk rating. A medium risk score indicates the stock can be bought and sold over time if one applies a delicate touch.

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